It’s tempting to pay little attention to an individual retirement account (IRA). After all, with a maximum contribution of $6,000 in 2021 and 2022 ($7,000 if you are over age 50), how much can an IRA contribute to the vast sums you’ll need for retirement? The answer is plenty, especially if you follow these tips:
Start contributing as soon as possible. That way, tax- deferred or tax-free compounding of earnings can have a dramatic impact on your IRA’s ultimate value. Consider the following example. Four individuals, ages 20, 30, 40, and 50, each contribute $5,000 to an IRA this year. What will that amount grow to when each person reaches age 65, assuming an 8% annual rate of return? The 50 year old will potentially have $15,861, the 40 year old will have $34,242, the 30 year old will have $73,927, and the 20 year old will have $159,602. Compounding of earnings turned the 20 year old’s contribution into a much larger balance.*
Contribute every year until you reach retirement. Even if you can’t afford the maximum contribution, contribute something every year. Over a period of time, a modest investment program can grow to a significant sum. Assume that at age 30 you starting contributing $5,000 per year to an IRA, earning 8% compounded annually.
After one year, you’ll have only $5,400. But that will grow to $29,333 after five years, $72,433 after 10 years, $228,810 after 20 years, and $861,581 after 35 years, when you turn age 65.* (Keep in mind that an automatic investing program, such as dollar-cost averaging, does not assure a profit or protect against loss in declining markets. Because such a strategy involves periodic investments, consider your financial ability and willingness to continue purchases through periods of low price levels.)
Select investments with care. Your IRA should be a long-term investment vehicle for retirement, so your investments should be appropriate for that long time frame. Even modest changes in your rate of return can substantially impact your IRA’s ultimate value. For example, assume you have $10,000 in your IRA, which will be invested for 30 years. If you earn an average rate of return of 6% com- pounded annually, your balance will equal $57,435. Increase that return to 8%, and your ending balance will equal $100,627, a difference of $43,192.*
Fund your IRA at the beginning of the year, rather than at the end of the year. This allows your contributions and earnings to compound for a longer period. For example, assume you are 30 years old and make $5,000 IRA contribution at year-end for 35 years. If you earn 8% compounded annually, your IRA balance would equal $861,584 at age 65. Make the contribution at the beginning of the year instead, and your balance would equal $930,511, a difference of $68,927.*
Please call if you’d like to review strategies to help maximize your IRA’s value.
* These examples are provided for illustrative purposes only and are not intended to project the performance of a specific investment. They do not take into account the effects of commissions or any taxes that may be due.
